Activist investors: persuasion, pressure and “decisions, decisions”

UK company law offers remedies to shareholders who believe that a company is being run against their best interests.

A member can petition the court under s 996 of the Companies Act 2006 if they consider that the company’s affairs are being conducted in a manner that is unfairly prejudicial to the interests of members.

If a director has breached their duties, they may be held liable by the court, the overriding duty now being that formulated in section 172 of the Act: “A director of a company must act in the way he considers, in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole.”

But such remedies may be of little practical use where the shareholder is merely one of many in a quoted company and where any question of what “would be most likely to promote the success of the company for the benefit of its members as a whole” is essentially a matter of judgment.

The only remedy then available may be the possibility of persuasion. Since the concept of the activist investor came to prominence in the 1980s, attempts to persuade have taken a variety of forms. They may be discrete or, on the other hand, organised and vocal (e.g. using the media). They may be aimed at the directors, other shareholders or both. Other shareholders may be enlisted to place pressure on the directors.

Barclays in focus

A well-publicised recent example of investor activism has involved Barclays, the activist being Edward Bramson of the New York “turnaround” investment firm Sherborne Investors Management. Sherborne began buying shares in early 2018 and, by early 2019, had an interest of around 5.5% spread across the funds which it managed, these including a Guernsey investment company called Sherborne Investors (Guernsey) C Limited (SIGC). Rather under half of the shares had been bought outright with the remainder being held through derivatives with maturities stretching out to 2021.

SIGS’s objectives and policies are publicly stated:

“(Its) investment objective is to realise capital growth from investment in a target company identified by the Investment Manager … (Its) investment policy is to invest in a publicly quoted company which it considers to be undervalued as a result of operational deficiencies and which it believes can be rectified by the Investment Manager’s active involvement … (It) will only invest in one target company at a time.”

The “operational deficiencies” perceived by Sherborne related to Barclays’ Corporate and Investment Bank (CIB). A letter to SIGC’s shareholders identified five particular areas of concern: (i) the valuation of investment banks tends to be lower than that of consumer orientated banks, (ii) the rate of return on capital diverted to the CIB was lower than if it had remained in the consumer businesses, (iii) the CIB was said to have legacy strategic weaknesses, (iv) Barclays had become a financial holding company rather than a “bank” and (v) long term investors had been deterred from acquiring shares by the CIB having become a “black box with too much leverage”.

The immediate remedy sought was the appointment of Mr Bramson as a non-executive director. This, it was said, would allow Sherborne to participate with the other Barclays directors, in a low?key way, in addressing the concerns which it had raised. That in turn should lead, said Sherborne, to Barclays adopting more conservative capital, leverage, and liquidity levels than strictly required by the regulators by way of a “judicious” reduction in the CIB’s assets.

These concerns plainly involved matters of judgment. The business models of investment banks have been the subject of extensive debate (not least amongst regulators) since the financial crisis of 2007/8. Mr Bramson wanted to be able to persuade the directors from the inside rather than the outside. As a matter of practicality, the more shareholder support he was perceived as having, the more potent might be his efforts to persuade.

Mr Bramson also described the tactics which Sherborne had adopted. There had been “a long process of consistent engagement”, extensive correspondence and several meetings, including a “pleasant and polite” meeting with Barclays’ Group Chairman and other directors. Barclays had told Sherborne that its directors would look forward to continued engagement, but that board representation would not be “needed”. It had proposed a further meeting following the announcement of its annual results in February 2019.

Mr Bramson, however, told SIGC’s shareholders that Sherborne did not have confidence that continued engagement with Barclays, strictly as an outsider, would produce any more measurable results in the future than it had to date:

“It seems increasingly likely that, for any progress to be made on our concerns, we will be required to seek a shareholder vote to make changes in the composition of the board. Were we to do so, the most pragmatic approach, in view of the calendar, appears to be for us to present resolutions to be voted on at the Annual General Meeting.”

That is indeed what happened. An AGM resolution that Mr Bramson be appointed as a director was requisitioned (but not recommended by the board). In the notice of meeting, half a page of the Group Chairman’s letter was devoted to explaining why the board did not consider that the appointment of Mr Bramson would be beneficial. A separate Board Statement (containing further detailed reasons) ran to a page and a half.

The Group Chairman observed that the Board’s understanding of Mr Bramson’s intentions was derived not from any formal statement but from his comments to shareholders (both of Sherborne and Barclays) and the media. On 8^th April 2019, Sherborne wrote to Barclays’ shareholders with Barclays responding on 11^th April.

Barclays also questioned whether Mr. Bramson’s interests were aligned with those of its shareholders generally. Sherborne’s holding was leveraged and a significant portion subject to time-limited derivative instruments to hedge against downside risk. This, said Barclays, reduced Sherborne’s exposure to the risks of Mr. Bramson’s strategies whereas other shareholders would suffer the full potential downside consequences. Moreover, it was likely to result in a shorter-term focus.

It was not Barclays’ position that the concerns raised by Sherborne were not worth of consideration at all. Indeed, it was said by the Group Chairman that “Mr Bramson has not made any suggestions for the Group that we have not already considered and concluded to be unfeasible and/or value destructive”. Similarly, the Board Statement explained that the “Board had previously considered and rejected Mr. Bramson’s request to join the Board as a non-executive Director”. The directors had thus already made at least two decisions.

The shareholders effectively had to decide whether to endorse one of those decisions (with any refusal to endorse the directors’ decision on the appointment of Mr Bramson being likely to be seen as a challenge to the board’s conclusions generally as to the future of the CIB). In casting their votes, they would have been informed by, on the one hand, what they had read of Sherborne’s proposals in the media, online and in its letter and, on the other, Barclays’ careful formal rebuttals of those proposals (prepared, no doubt, with the benefit of expensive legal advice).

If they were institutional or sophisticated investors, they may well also have had their own analysis of the underlying issues. In the event, as has been widely reported, Resolution 24 was not passed at the AGM on 2^nd May, with under 13 per cent of the votes cast being “For” and over 87 per cent “Against”. Mr Bramson did not speak from the floor. What will happen next remains to be seen.

Directors’ duties

So much for the tactics adopted in this particular case. That leaves the wider question of what steps companies can take to protect themselves from this type of potential shareholder action. Company law is not concerned with the regulation of persuasion or pressure (unless, of course, that pressure is unlawful or improper). That is not to say that company law is irrelevant. Directors must always be conscious of their duties (including the section 172 formulation).

It may be trite (but necessary) to observe that when taking any decision, directors must ensure that they are doing so for proper reasons and have followed a proper procedure. They may need to be ready, willing and able reasonably to justify that decision. If they are able do so, the law is likely to cut them considerable slack on pure matters of judgment.

The need to carry shareholders with them necessarily raises subtler issues. Every case will be different. There can be no bright line tactical rules (let alone legal rules). Barclays must have devoted considerable resources in terms of both time and money (including legal costs) to the process of deciding what response it should make to Sherborne’s concerns and how that response should be communicated to shareholders. In 2018, shareholder objections caused Unilever to abandon its plan, in effect, to transfer its domicile to the Netherlands. Decisions relating to remuneration can be particularly susceptible to concerted shareholder resistance.

Ultimately, proper decision making is a facet of proper management. Even from a lawyer’s perspective, it is hard to improve upon the practical advice given by Mr Warren Buffett at a conference in Washington, D.C. in October 2015:

“If every company were well managed, there would be no reason for activists … The best way to keep activists away is to perform reasonably well in your business and to communicate with your shareholders. They should be treated as partners.”

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